Through this article in the light of Creel (2003) "Ranking Fiscal Policy rules: the Golden rule of Public Finance vs. the Stability and Growth Pact" paper, we try to explain the importance of setting a fiscal rule framework for a country or area. The assessment of the fiscal rules frameworks is analyzed in the third section, based on Creel, Buti et al., other economic and empirical literature, adding also our opinion on these fiscal rule frameworks. Referred to the criteria for an optimal fiscal rule, we have suggested a double fiscal rule which would be the most appropriate one in the case of Albania.
The study reflects a comparative analysis between SGP and the modified golden rule, in order to identify the best fiscal rule in the European Union. Even though European countries conduct fiscal policies independently by each other, their implementation process remains important, due to negative effects that specific policies might trigger to the price stability objective in the medium term. In order to avoid these negative implications, Maastricht and Amsterdam Treaties have set limits to the public debt and public deficit. Developments in the public finance of different countries in the Eurozone up to 2003, show the inability of the SGP to fulfill its main objective in ensuring fiscal prudence and discipline. So Buti et al. (2003) assess the performance of the SGP based on the eight characteristics of an ideal fiscal rule by Kopits and Symansky (1998). As a consequence, the SGP required modifications, identified by Buti et al are focused on enforceability and efficiency as the main drawbacks of the Pact, adding also transparency and flexibility, as the features proposed to be part of the modified Pact. Meanwhile, Creel reassessment suggests that more flaws are present in the Pact, showed mainly by the developments in specific countries.
Therefore it is discussed the possibility of the adoption of a golden rule in the EU, which is supported theoretically (the spreading of the public capital formation costs over the years it is being used) and empirically (cases show a negative relationship between fiscal consolidation and capital expenditures). A fiscal rule that targets public deficit excluding public capital formation, will positively influence the potential and actual economic growth, due to a larger amount of public goods and a higher level of the overall welfare. This definition brings into attention the UK case, where the adoption of the golden rule is associated in the same time with that of the sustainable investment rule, which sheds light in the main drawback of simply adopt the golden rule. Thus the adoption in EU of a golden rule in public finance on the cyclically - adjusted net - of - public investment deficit without sustainable investment rule, would endogenously limit public investment growth. Criticism is mainly related to the growth in public debt, cost/benefits analysis, a concentrated growth mainly in physical assets compared to expenditures in health and education, and also in public capital compared to overall capital. It is therefore suggested the adoption of a modified golden rule that targets a cyclically adjusted deficit without public investment. Creel has assessed this rule based on the eight features of Kopits and Symansky (1998), having the same result as for the SGP. Even though Creel concludes that the target of a cyclically - adjusted net of public - investment balance is a better choice in EU, enhancing the fact that too much work is needed to set a well defined, transparent and enforceable rule. Regardless of a low simplicity feature, this rule stresses the positive effects in boosting the potential growth, lowering the economic fluctuations and not jeopardizing the price stability in EU.
Before the assessment of the fiscal rules framework, it is necessary creating a background about the importance of fiscal rules, their trend during the time, and the main types of fiscal rule.
A fiscal rule is defined as a permanent constraint on fiscal policy through simple numerical limits on budgetary aggregates (Kopits and Symansky, 1998). By adopting a fiscal rule, some constraints are posed to the fiscal policy, in order to maintain the fiscal sustainability in long run.
Fiscal sustainability is an important concept in assessing the current fiscal policy stance and based on these initial conditions evaluate whether this fiscal policy path is sustainable in the long run or not. There is not a unique definition of long-term sustainability of public finances. In the absence of an agreed definition in the literature, we can use a pragmatic definition of what constitutes a sustainable public finance. The term fiscal sustainability has many definitions, though it almost always refers to the fiscal policies of a government or the public sector. Burnside (2004) uses two concepts of fiscal sustainability. The first one relates to solvency, the ability of the government to service its debt obligations in perpetuity without explicit default. Another concept of fiscal sustainability relates to the government's ability to maintain its current policies while remaining solvent. With this concept, fiscal sustainability analysis has broader scope. At the other hand, the assessment of long-term sustainability of public finances too, is a multifaceted issue and there is not a unique indicator that provides a clear response to what extent a country's public finances are sustainable in the long run. A lot of research is done to find out the best practice in assessing the fiscal sustainability, but it's worth mentioning the two main approaches used in fiscal sustainability assessment: Sustainability indicators (first introduced by Buiter, 1985 and Blanchard, 1990) and Sustainability tests (which are very sensitive to the data quantity and quality).
Fiscal sustainability is an important precondition in achieving macroeconomic stability and promoting economic growth in long run. The experience of countries adopting a fiscal rule framework has shown that this practice has supported fiscal consolidation, has increased the credibility of the fiscal policy, and moreover has ensured fiscal sustainability in long run.
The increased perceive of the market players (both domestic and foreign) towards credible fiscal policy, implies a reduction in risk premium, therefore a decrease in interest rates and as a consequence, an increase in private investments.
Economic literature suggests some of the below mentioned advantages of fiscal rules:
- Reduction in borrowing cost. High level of borrowing, exceeding the expected or projected levels, implies a down fall in the credit rating, and a confidence derogation in the financial markets, which leads to higher interest rates on the forthcoming borrowing. By imposing a fiscal rule, the governments are enforced to respect the medium term fiscal framework (not exceeding the limits defined for the fiscal variables), inducing macroeconomic stability and fulfillment of the expectations, which in turn reduces the borrowing cost.
- Safeguard the sustainability of public finances in the long run, promote growth and support intergenerational equity. Expansionary fiscal policy in short run benefits the current government, while inheriting debt stocks to the next governments. Such a feature of the fiscal policy is related to the concept of time inconsistency of the fiscal policy: pursuing short terms objectives, different from declared long term objectives. The idea of time consistency, developed by Kydland and Prescott (1977) focuses instead on the strategic idea that policies that yield short-term benefits are negated in the future by changes in expectations. A well defined, efficient and adequate fiscal rule can help in avoiding the time inconsistency feature of fiscal policy, and in not inheriting the current obligations to the future generations.
- A smooth in the business cycles: According to Alesina and Tabellini (2005) most economists would agree with the normative prescription that tax rates and discretionary government spending as a fraction of GDP ought to remain constant over the business cycle. If governments respected these prescriptions, during a boom: (i) government spending as a share of GDP should go down because of automatic stabilizers (if discretionary spending remained constant in real terms, the effect would be reinforced); (ii) with constant tax rates and some degree of progressivity, government revenues as a share of GDP should go up (the effect would be reinforced by tax cuts in recessions and tax increases in boom.); (iii) as a result, budget surpluses as a share of GDP should increase. The opposite should occur in recessions. In practice, in many developing countries fiscal policy has the opposite properties: it is procyclical. In particular, government spending as a share of GDP goes up during booms and down in recessions, while deficits increase in booms and decrease in recessions, thus we should observe a counter-cyclical pattern in fiscal policy. Gavin and Perotti (1997) were the first to point out that in Latin America fiscal policy is procyclical, but Talvi and Vegh (2005), Catao and Sutton (2002) and Kaminski, Reinhart, and Vegh (2004) noted that this is not a Latin American phenomenon only: procyclicality of fiscal policy is common in many � though not all � developing countries. In bad times many developing countries cannot borrow, or can do so only at very high interest rates, therefore they cannot run deficits and have to cut spending; in booms they can borrow more easily and choose to do so, increasing public spending. Alessina et al. (2005), conclude that procyclicality of fiscal policy results from a government failure, not a market failure, and takes place irrespective of whether or not the government is up against a credit limit. Fiscal policy is procyclical because rational but uninformed voters "starve the Leviathan" and demand more in good times than in bad times.
Adopting a fiscal rule, which takes into account the business cycles (ie cyclically adjusted budget deficit) can stimulate the countercyclical fiscal policy, which has proved not to cause inflationary bias.
- supporting fiscal credibility, discipline and fiscal consolidation in later stages. This is the key feature in achieving and maintaining macroeconomic equilibriums in place. The soundness of fiscal policies becomes particularly important under a transparent regime such as inflation targeting. According to Alessina et al. (2000) if both fiscal and monetary authorities follow clear rules (such as balanced budget and inflation targeting respectively) consistent monetary policy and fiscal policies will be set out, supporting thus the equilibriums in the economy.
To summarize, we think that adoption of an optimal fiscal rule should be designed in such way, that it ensures a sustainable debt stock in the long run, by maintaining public deficits consistent with the economic growth and interest rates paid on debt and leaving the automatic stabilizers operate. Fiscal rules foreseeing automatic enforcement mechanisms seem to have a larger influence on budgetary outcomes.
When looking at fiscal developments in a long-term perspective, it appears that episodes of protracted departure from budgetary balance have been rather uncommon in the history. Up to the first oil price shock, budgetary deficits were almost exclusively related to war episodes and were typically corrected promptly (EC, 2004). The picture changed from the 70s onwards, when sustained deficits not related to exceptional public finance needs as during war periods were recorded in the most advanced economies. In this view the fiscal rules are laid back on this history. As early as the mid-nineteenth century, subnational entities of federal countries were subjected to legislated rules to avoid large fiscal deficits and free-riding risks (Kopits, 2001). After World War II, Germany, Italy, Japan, and the Netherlands incorporated budget balance rules at the central or general government level into their stabilization programs. Later, excessive public debts accumulated during the 1970s and 1980s by many countries prompted a growing number of them to subject their policies to numerical constraints, including the United States, Canada, and various Latin American countries in the late 1990s. In European Union member states, however, supranational fiscal rules (Maastricht Treaty in 1992, Stability and Growth Pact in 1997) originated from the need to constrain individual countries from running fiscal policies inconsistent with the needs of the economic and monetary union. Increasingly, EU members have complemented the EU framework with national fiscal rules (EC, 2009). In many cases, fiscal rules have been introduced as part of broader reforms aimed at strengthening the framework for fiscal policy. In recent years, an increasing number of countries have relied on rules to guide the fiscal policy (as illustrated in the graphs below).
A sound fiscal rule framework gains importance especially after 2008 financial and economic crisis hit. Most of the countries, in response to the crises depending on their respective fiscal space have implemented fiscal measures in order to boost the falling aggregate demand. The fiscal stimulus provided was accompanied of course, with a sharp increase in fiscal deficits and public debt and in many countries has raised concerns about the sustainability of public finances. Given the increase in public debt, and the uncertainties about its sustainability in long run, the number of countries implementing fiscal rule frameworks, is expected to be even higher after 2009.
Before briefing the fiscal rule types, its worth mentioning that they are set out in national and supranational level. Although their main objective remains same (supporting fiscal credibility and discipline, ensuring thus fiscal sustainability in the long run) their budgetary outcomes has differed. The most important supranational fiscal framework is the Stability and Growth Pact, which sets out the rule based framework for the EU countries. EU members are bound to avoid excessive deficits (defined with reference to a 3 percent of GDP threshold for the general government deficit) and reduce their public debt-to- GDP ratio to below 60 percent. In addition, they commit to aiming at structural balances close to balance or in surplus (with country-differentiated margins). The provisions of the SGP apply to all EU members, although provisions for imposing sanctions for non-compliance apply only to members of the euro area. The SGP, in force since 1997, is based on the Treaty of the European Union ("Maastricht Treaty)," adopted in 1992, and consists of two EU regulations with force of law complemented by European Council resolutions.
While the national fiscal rule frameworks differ from the prospective of the fiscal variable constrained, they have a common feature: they promote fiscal sustainability. The main fiscal rules are (IMF, 2009):
A monetary union needs coordination and a continuous improvement of fiscal policies. There are several reasons that support this process such as: an effective monetary policy couldn't tolerate large fiscal disequilibrium's; high fiscal deficits and public debts may influence the objective of monetary stability; countries that run high fiscal deficits may be a source of negative externalities for other countries, due to a common capital financial market in the monetary union and also the unsustainable public finance in some EU countries may have effects in the euro performance in the long-term. The coordination of fiscal policies may happen either through market forces or by conducting a fiscal rule that determines fiscal policies.
The widely divergent trends in the public finances of the EU countries, and the different reputations of the governments supported the idea of the adoption of the Stability Growth Pact, in order not to leave the process of fiscal convergence to the discretion of the individual countries' policymakers. SGP should set some necessary limitations to that discretion, but also leave the governments free in the pursuit of their fiscal actions (as leaving countries free to determine the level of public spending or taxation they desired). Being in force since 1997, SGP consists of two EU regulations and sets out in detail how the rules of the Maastricht Treaty are applied. Therefore, SGP is as kind of supranational-rule based fiscal framework that aims to prevent excessive budget deficits emerging in the European Union, ensuring sound management of public finances in the union.
Buiter (2003) gives the two Stability Growth Pact rules as follows: (1) The general government financial deficit can be no higher than three percent of GDP, except under exceptional circumstances (under conditions of 'severe recessions'). (2) Over the medium term, the general government financial deficit should be 'close to balance or in surplus'.
Based on the above mentioned rules, the Stability Growth Pact is supposed to ensure fiscal prudence and discipline in the union area, but what countries (Portugal, Germany, and France) experienced during 2002 and 2003 highlight possible drawbacks and modifications of the Pact.
Many of principles listed by Kopits and Symansky (1998) for a fiscal rule to be optimal are interlinked and cannot easily be separated. For example, the enforcement process should be credible and consistent to secure transparency of the rule. Also the simplicity of a rule expressed as a numerical target is meaningless if there is added flexibility in its interpretation when it comes to enforcement. As a result it can be noticed significant trade-offs between them, which require compromises along some dimensions.
Buti et al. (2003) in order to assess whether the fiscal rule of the Pact is well defined or not focus more on the definition of the rule expressed in terms of the indicator to be constrained, arguing that 'medium term' and 'close to balance or in surplus' are quite ambiguous, living room for different interpretations. Meanwhile, Creel (2003) expands the discussion to the institutional coverage, which again points out an inconsistency functioning of the European Commission and Ecofin Council mechanism. In our opinion, the evidence coming from Germany and Portugal in late 2002, Italy in mid-2004, where the well-founded Commission early warning recommendations for these countries were declined by the Council, supports Creel (2003) lower value for the well-defined feature of the SGP.
The transparency property of SGP is mainly related to the preventive arm of the Pact, which requires a submission of EU countries annually programs on their medium-term budgetary strategy, which includes policies to achieve medium term budgetary objectives by the member states (for euro zone countries 'stability programmes', for the other EU countries 'convergence programs'). Buti et al. (2003) points out a low level of transparency mainly due to the undefined roles of the Commission and national forecasts in the assessment of the Stability and Convergence Programmes. In order to improve transparency Buti et al. propose one-off measures to be publicized and to be excluded from the domestic structural balance targets insofar they are really temporary, but it isn't given a definition for the one-off measures. Whereas Creel (2003) argues that transparency is even lower, what it is left as undefined by the SGP, is interpreted and imposed by the EC. However we think that the revision of SGP in 2005, which includes differentiations of the medium-term budgetary objectives across countries taking into account the respective debt ratios, the potential growth and the implicit liabilities from age-related spending, has contributed to ameliorate the transparency feature. Adding also that it is foreseen an annual adjustment of 0.5 percent of GDP as a benchmark for euro zone and ERM II members in the case countries deviate from their MTO, and the issuing of Council of Minister's opinion based on the assessment by the EC for the Stability and Convergence Programs, the transparency of the Pact is expected to grow.
SGP represents a simple rule according to Buti et al (2003) and Creel (2003) as it is expressed through a symbolic figure to the public and an understandable public finance concept as the general government public deficit. We agree with the remark made by Creel (2003) that a good communication will make the rule even simpler by a clear understanding of what the underlying target incorporates. We also support Buiter'(2003) critique related with the 'close to balance' expression in the rule as not too clear.
A fiscal rule to be optimal should also be flexible to respond to shocks (output, inflation, interest rate and exchange rate volatility and other temporary shocks), but this doesn't mean that it is equal to opportunistic or weak. Buti et al. (2003) consider SGP more flexible than does Creel (2003). Buti et al (2003) propose the improvement of flexibility by the adoption of a cyclically adjusted deficit, but with a special feature, the fiscal rule should be diversified. The SGP numerical constraints, the timeframe for adjustment and/or escape clauses build its flexibility feature. But as Creel (2003) argues, it is not included in the escape clauses the possibility of an economic slowdown. The revision made to the SGP in 2005 had as a main purpose to provide greater flexibility to the pact. So the possibility to revise recommendations for the correction of the excessive deficit, a longer timeframe in case of deterioration of economic conditions with major impact in public finances and the explicit requirement of a minimum annual structural adjustment of 0.5 percent when a country is under excessive deficit procedures where all included in the revised pact. Based on these modifications, we think that SGP enjoys more flexibility. However it is worth to mention that during the crisis, 20 of 27 members of the EU have initiated excessive deficit procedures and long deadlines for correcting the deficits are endorsed.
Regarding the adequacy feature Creel (2003) states that the SGP has failed, whether or not the goal remains unchangeable. According to him the weaknesses of this feature are related mainly with the procedures and the mechanism. We agree with his argument, meanwhile the crisis of 2008 has tested again the effectiveness of SGP. During a good economic performance, countries didn't build up public finance buffers, and as a result twenty of twenty seven EU countries are under EDP.
According to Buti et al (2003) and Creel (2003) regarding the enforceability feature, the Pact lacks the existence of this property. Countries experiences show that this is mainly related to the mechanism that enhances the enforceability feature of the rules. This mechanism functions as follows: the first instance of an early warning is done by the European Commission and the final instance of the early warning procedure is adopted by the Ecofin Council. Both of them don't have the legitimacy (the Commission) and the competence and collective capacity (the Ecofin Council) to commit to an impartial, consistent enforcement of the rules. In order to enhance enforceability Buti et al. (2003) suggest EC recommendations to become proposals, which would necessitate the unanimity, rather than qualified majority that would reject them. We support the idea expressed by Buiter (2003) that potential effective instruments to induce compliance with the rules may be moral suasion, peer pressure and 'naming and shaming'. Also, it is quite obvious that the imposition of sanctions as fines (in extreme cases) for countries that would persistently not fulfill the rules, may aggravate the problem shown ex-post in order to prevent it in ex-ante. Furthermore sanctions are generally difficult to be implemented and their effects are likely to come with delays. In some cases they may result in political instability, limiting further their effectiveness.
The consistency feature of a fiscal rule is mainly related to the internally consistency of the rule and the consistency with other macroeconomic and structural policies. Creel (2003) gives a bad value to the consistency feature of the SGP mainly based on the policy mix in EU. Regarding to him the lack of enforceability of the policy mix, a high discretion left to countries in the EU to implement their fiscal rules and a "reluctant behavior" by the ECB to reduce government deficits are the key elements where Creel (2003) focuses to criticize the consistency property of the Pact. It is also another dimension of consistency with respect to the final goal of the sustainability of the fiscal position. We support the conclusion of the analysis of Visaggio (2004) that shows that the revised Stability Growth Pact removes the inconsistency of the numerical fiscal rule on the total budget balance (from 3 percent to 0 percent to the structural total budget deficit) with the numerical final goal on the public debt, so that in the long run the public debt has to be retired entirely. We also argue that a strong emphasis on annual targets may create a tension between fiscal policies and structural policies (for example the Pact may prevent countries from implementing policies - such as pension reforms which improve sustainability over the medium and long term at the price of a temporary worsening of the deficit), which affects the consistency property of the Pact. Furthermore, the three percent deficit ceiling is not a cyclically adjusted rule, being inconsistent with the free and full operation of the automatic fiscal stabilizers.
Finally, the efficiency feature is mainly related to the policy actions or reforms to be adopted in order to ensure sustainability. The efficiency property enables a rule to meet the given objectives while minimizing any costs or side - effects that might impose on the economy. Creel (2003) values less the efficiency property of the Pact compared to Buti et al (2003), due to the absence of incentives to stimulate governments to increase public surplus or to implement fiscal reforms. Buti et al. suggest that efficiency can be enhanced through increasing transparency, because it is not sure if the one off measures will lead governments to implement tax reforms.
Summarizing, we have selected some of the main concerns related with the effectiveness of SGP, which are: the rules have to be as neutral as possible regarding countries social preferences which are heterogeneous in the EU; trade - offs between various criteria are influenced by the multinational nature of the rules; and lastly as Dixit and Lambertini (2003) state the growing interaction in a monetary union imply a close connection, which requires a mechanism that on the one hand disciplines one side and rewards the other side
The golden rule is a budget balance rule, and specifically over the cycle it targets the overall balance net of capital expenditures, so the government will borrow only to invest and not to fund current expenditures.
According to Creel (2003), there are several reasons that support the golden rule as a possible alternative, such as the necessity of spreading the costs of public capital formation over the time they will be used, which is going to put an end to this negative bias. In our opinion, spreading the burden of capital expenditures over the different generations of taxpayers and the avoidance of the efficiency loss caused by distortionary taxation if the tax rate fluctuates over time are considered as the main advantages of the golden rule. Also, the final target to boost potential and actual economic growth can be easily reached through public investment. Furthermore, Creel (2003) considers the adoption of the golden rule in EU as a good approach to minimize the differences in the budget practices followed in the EU and the UK. Regarding the critique done to the golden rule Creel (2003) selects the 'unsustainable' feature as the key flaw. We think that from the point of view of debt sustainability what really matters are the returns that can be appropriated by the government to reduce the debt. So, even the social rate of return on public investment is higher than the rate of return on private investment would not necessarily make sense regarding debt sustainability. Based on the EC (2003, part III), he states that it would be a biased argument if the golden rule would stop the reduction in public debts, as the demand side impact shouldn't be neglected. Also another issue of discussion is that the rule refers to net spending, so to the net addition to public capital that should be financed through borrowing while the part that covers depreciation should remain tax - financed. In the developing countries, estimates of amortisation are not available, where the infrastructure is partly developed by subjects not included in general government. According to Creel's discussion, the incorporation of a sustainable investment rule in the golden rule, would limit public investment growth. Setting limits will also include an appropriate cost/benefits analysis of the financing investment project. Another important issue that Creel supports regarding the golden rule is related with a possible revision of public accounting and practices, in order that the promotion of public investment will not result in a biased increase of the public expenditures at the expense of current expenditures as training, R&D, education and health that would result in the accumulation of human capital. According to us this raises the attention to the question if all capital expenditure is necessarily productive, whereas other items such as expenditures on health and education may raise productivity and potential growth even more. Lastly, he points out another critique to the rule as it boosts the public capital and not the overall capital. Regarding this issue Buti M. et al (2002) argues that singling out public investment from other budget items makes little sense. Moreover, empirical literature doesn't show that investment in public infrastructure always leads to significant positive growth effects. We think that such a rule will create incentives for governments to classify current expenditures as capital spending, providing leeway for opportunistic behavior (that makes the multilateral surveillance process more complex) and will hamper the conduct of stabilization policies during recessions, representing potential important shortcomings in the case of catching up economies.
As for the Stability Growth Pact, Creel (2003) evaluates the modified golden rule, which he defines as a cyclically - adjusted, net - of - public - investment deficit at the value of zero percent of GDP, based on the criteria set by Kopits and Symansky (1998), as an alternative to be adopted in EU. He doesn't value the well - defined, transparency and enforceability feature of the modified golden rule as it is not adopted as such, but he points out the importance of politicians' willingness to improve the fiscal institutional framework within the EU. In our opinion, the institutional framework should remain in focus regarding the implementation and monitoring process of the rule, in order to prevent possible manipulations and not impeding democratic accountability mechanisms, and that will create the proper incentives.
The modified golden rule involves both cyclically adjustment and a judgement about what constitutes public investment, which is considered to be quite difficult. So in order to improve the simplicity feature of the modified golden rule, Creel (2003) proposes an ex ante methodology used to compute the cyclically - influenced components and the precise goal for 'public investment'.
Being a cyclically adjusted rule the modified golden rule allows the operation of automatic stabilisers, and as governments are free in the choice and size of public investment, it is possible to counter shocks and to improve the potential output. Based on these arguments Creel (2003) gives a very good mark to the flexibility feature.
According to Creel (2003) the adequacy of the rule is marked as good as the consistency and efficiency property, deserving top-marks, as it is supposed to boost potential growth (since borrowing takes place only for productive investment) and not to jeopardize price stability, being consistent with monetary policy in euro zone. Under this fiscal rule, governments can manage more freely the cyclically - adjusted deficit, or implement different tax reforms and public investment programs, which enhances the efficiency property of the rule.
Even though Creel (2003) values the modified golden rule as Buti et al. (2003) value the Stability Growth Pact, he argues that the introduction of the rule in EU could be a better mean to encourage public investment programs and economic growth.
For most of the time, since the start of economic reforms in early 1990s, the standard IMF conditionality (the limits on government net domestic borrowing and on non-concessional external borrowing) have served as an anchor for the fiscal policy. Now that Albania has graduated from the IMF-supported programs (January 2009) and considers accessing international capital markets, the question arises whether it would be desirable to introduce an alternative mechanism to promote sound fiscal policy and fiscal discipline. Actually there is no explicit anchor for the fiscal policy, except the 60 percent debt to GDP ratio defined in the "Organic law of the budget, 2008".
Given the actual conditions of the fiscal developments, taking into account the deterioration of the budget balance during the last two years and the accumulating debt stock, adopting a fiscal rule is a necessity in case of our country. The outcome of a fiscal rule would be (i) increased fiscal policy discipline and credibility; (ii) fiscal consolidation; and (iii) fiscal sustainability in long run.
Before deciding for the most appropriate fiscal rule, three preconditions should be fulfilled:
i. There should be a close link between the variable to be constrained and the final objective of the fiscal policy;
ii. A clear guidance for the fiscal policy should be provided, controlled, and monitored;
iii. The fiscal rule should fulfill as far as possible 8 features of an "ideal" fiscal rule defined by Kopits and Symansky (1998).
Compliance to the SAA agreement requirements in several areas such as political, economical, legal etc., is the current challenge for Albania. Although pre-accession period may take several years (before joining to EU), all the requirements should be accomplished. One of the challenging tasks is legal framework harmonization with the EU one.
So, during the pre-accession period, several frameworks of EU in economic policy area, or other areas might serve as benchmarks for Albania. If we consider one of these benchmarks to be achieved, such as criteria defined in SGP, than a question rises: are 3 percent deficit level and 60 percent public debt ratio to GDP the most rationale ones in case of Albania?
In the organic law of the budget, which was revised in 2008, there is a statement that the public debt stock ratio to GDP should be less than 60 percent. In line with the requirements of SAA, we can argue that, the main pillar of the restraints defined in SGP is somehow set out in the Albanian legislation. But there is still missing the other pillar of the SGP: deficit rule. In current situation such a rule lacks the enforceability feature of an ideal fiscal rule. Actually there is no law which stipulates the upper limit for the budget deficit, or any sanction in case of exceeding the upper bound for the public debt. There exists a commitment of the government to reduce the expenditures planned initially for 2010, by 20 billion ALL, but that commitment is still not credible, bearing in mind that during the last two years fiscal policy - mainly because of Durres-Kukes road expenditures - was expansionary.
Moreover, a public debt stock of 60 percent of GDP may not be the optimal one in case of Albania.
Referring to the public debt stock data for the South Eastern Europe countries, Albania has the largest debt stock ratio to GDP (except Hungary). In average, the public debt stock ratio, in 2009, for the South Eastern Europe countries is around 33.4 percent, while the current debt stock for Albania is 58.3 percent of GDP. Taking into account the relatively low level of income and potential vulnerability to adverse the shocks we judge that the optimal debt ratio in case of Albania should not be higher than 40 percent of GDP, in medium to long term horizon.
To conclude, the SGP criteria, to our opinion, are not the optimal solution in choosing the fiscal rule framework, at least in medium to long term period, because it is no clear evidence whether such a debt stock limit ensures fiscal sustainability in long term, thus the adequacy feature is not carried out by this type of fiscal rule. Regarding to the fulfillment of other properties of an ideal fiscal rule we can say that such a rule in case of Albania, as well as in other countries, faces a trade off between these features. As it is argued in previous sessions, we think that such a rule has a simple feature, is understandable by the public, may be at some extend it is flexible (take into account the latest revision), but it lacks other properties such as consistency and efficiency. May be it is the case to say that such a rule is inconsistent with the cyclical fluctuations leaving less space for fully operating automatic stabilizers. Moreover, as stated before such a rule, as well as not adequate, is not very efficient regarding with the final objective of the policy: maintaining the long term sustainability of public finances.
Such a rule states that over a cycle the government borrowing should not exceed the net capital formation, meaning that the current receipts should be equal to the current expenditures.
The data shows that the first precondition of the golden rule - current expenditures and receipts equalization - is fulfilled in the case of Albania.
If this rule could be combined with a sustainable investment rule (as in case of UK), the initial conditions regarding to the debt stock ratio seem to be not favorable in our country (the debt stock ratio up to the third quarter of 2009 is estimated at 58.3 percent of GDP, quite higher from 40 percent targeted in UK). To reduce the public debt by this amount in the medium run, would require a sharp fiscal adjustment, which would come from revenues side (meaning an increase in tax rates), expenditure side (reduction of government expenditures), or combination of both of them. But, we think that it would lack the political commitment for these large scale fiscal adjustments, because of the myopic feature of the fiscal policy. The government will not be reelected if it raises the taxes sharply, or reduces the expenditures for providing public goods and services sharply.
At the other hand, excluding the capital expenditures from the ceiling is another drawback of this rule to be applied in case of Albania. Such a rule states that over a cycle the government borrowing should not exceed the net capital formation. Calculation of the net capital formation (because of the lack in statistical data) is quite hard in current circumstances, thus not quite simple to be implemented. Moreover, the infrastructure is still weak in Albania, meaning that the capital expenditures in medium to long term will be more or less at the same amount as in the recent years, - implying not a consistent feature of ideal fiscal rule-, and creating thus a higher borrowing level needs. Operating still, under not deep/developed financial markets, the increase in government borrowing will imply an increase in interest rates paid on debt (as the issuance of the government bonds will be higher than the previous years). At the other hand, crowding out the private sector may be possible. Another alternative may be borrowing from foreign markets. Given the credit rating (B1) for Albania, the alternatives of borrowing from foreign markets, would add the exchange rate risk to the debt stock, although it may be sometimes cheaper to borrow outside the country. To conclude, we think that such a rule wouldn't serve as an anchor of fiscal policy to achieve and maintain fiscal sustainability in the long run, thus not adequate, because the public debt dynamics can be deteriorated from the changes in the interest rate and economic growth developments.
Modified golden rule can be formulated the same as the golden rule framework with the single difference that it takes into account the business cycles of the economy. This feature of the modified golden rule procedure can leave room for maneuver during the "bad times", meaning that there would be more space for countercyclical fiscal policies.
Although, this anchor might provide benefits from the room of maneuver possibility, it is not the appropriate fiscal rule which can implemented in case of Albania. The arguments against such a rule, at the current situation in Albania are the same with those ones to Golden Rule procedure. As a conclusion, the modified golden rule can not serve as the right anchor to discipline the fiscal policy, to ensure fiscal consolidation, and moreover to maintain the fiscal sustainability in the long run.
The experience of the countries lacking fiscal discipline shows that increase in credibility of the fiscal policy can be achieved by adopting a double fiscal rule. The most appropriate variable to be constrained first, is budget deficit (or at best case primary balance), as it fulfills almost all the preconditions of an appropriate fiscal rule framework. For complementing budget deficit rule the best variable to be constraint is public debt as a percentage of GDP.
We will analyze this type of fiscal rule in terms of budgetary outcomes and the fulfillment of the "ideal" features of a fiscal rule.
This kind of fiscal rule - by combining the limits over primary balance and public debt as percentage of GDP- can be considered as a sufficient measure to improve the fiscal discipline in the short and long run. Setting limits to the primary balance (which is equal to overall budget balance net of interest payments), rather than budget balance, is the optimal way to catch the impact of fiscal policy stance on the public debt dynamics. At the same by excluding the interest payments from the ceiling, there is a possibility to isolate the fiscal policy from the fluctuations in the financial markets. However, while adopting this rule some flaws regarding to the projections of macroeconomic variables are present, which may lead to unrealistic fiscal policy in short run.
To our opinion restraining the public debt as a certain percentage of GDP (may be 50% in medium term) needs some legal amends in this regard. First of all, the legal framework should be set, in order to determine the limits for both variables (primary balance and public debt). Another complementary amendment to the law - which is not defined in any other fiscal framework (SGP, Golden Rule, or Modified Golden Rule),- should be the well definition to the destination of the privatization receipts. The main reason of this amendment is that will not leave too much space to fiscal authorities to use the privatizations receipts to provide some extra public expenditure. Instead of that, the best solution should be the use of privatization receipts to lower the public debt stock. The experience of the EU countries in order to fulfill the debt criteria in SGP, shows that these countries have faced a drain in the public assets. That is exactly the same situation in case of Albania, during the last two years. A considerable part of the privatization receipts have been used to increase the public expenditures, instead of using them to lower the public debt stock, which is in contrary to structural reforms.
By setting limits over the primary balance and the public debt the most important features of an ideal fiscal rule can be fulfilled; such as adequacy - as they are expected to ensure fiscal consolidation in short term and fiscal sustainability in long period - ; consistency - because it is expected to be in the same line with the fiscal and structural reforms; efficiency - as it is expected to meet the final objective by contributing to the overall macroeconomic equilibriums - ; flexibility - as it leaves room for maneuver during booms or recession to follow a countercyclical fiscal policy -; simplicity - as it will be expressed in numerical targets it will simple to be implemented in legislation, but somehow simple to the public because we think that the debt rule is to some extend not very understandable by the public.
The main shortfalls of this rule are related to the "well defined", "transparent" and "enforceable" features of the ideal fiscal rule. Because these elements require the government commitment to improve the fiscal discipline and credibility in the short run, to help at the same time to public finances sustainability in the long term.
The current economic and financial developments highlighted once more the importance of setting a sound fiscal framework. While the fiscal rule is defined in terms of consistency with nation's priorities and policies, in order to preserve macroeconomic equilibriums in medium to long run, it may create some impediments to the supranational framework. This is the main reason we can not chose either the Stability Growth Pact or the Golden rule as the best fiscal framework for the EU countries. In the case of Albania, we have concluded that a double fiscal rule would be an appropriate option to be implemented. The arguments that support such a rule lead to a strengthening of fiscal discipline, will enhance the fiscal credibility and will serve as an anchor to fiscal sustainability in long run.
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 For example any fiscal rule which sets a lower boundary for revenues.
 A sanction mechanism in EU is not considered as the best solution for the case, because it focuses in the price stability goal for the whole area, without solving the main problem. It might have even negative effects, aggravating the situation for the countries with financial problems.
 As the golden rule states that current expenditures should be financed by current revenues, it implicitly sets a growth limit for the current expenditures. Due to a lower bound that other non-interest current expenditures face, therefore it exits an upper bound for the interest expenditures, which will also represent a ceiling for public borrowing's and public investment's growth. By introducing rigidity in the expenditure structure the fiscal rule may have impacts on the inefficiency of local governments' decision making. According to Pereira P. and Silva J. (2008) argues that this can result in a fiscal stress in urban municipalities, whenever there is a decreasing trend in per capita intergovernmental grants, and this trend can not be fully explained by the existence of economies of scale.
 According to Blachard and Fischer (1989), the modified golden rule derives from efficiency considerations of the growth path and the preference for the current versus future consumption of economic agents. In practise, the modified golden rule is usually adopted in advanced economies on average over sufficiently long periods that include several business cycles.
 Because the governments will pursue policies, whose outcomes will be a public debt stock at around 60%, and they may not effort lowering this threshold below 60%.
 The latest assessment was done by Moody's ( December 2009) and the credit rating remained same as in the previous assessment.
According to Aky�z (2007) the main indicators in the public debt sustainability assessment are : economic growth rate, interest rates paid on debt, inflation rate and the primary balance - overall balance net of interest payments-. The debt dynamics is deteriorated if (g) real growth rate is lower than the real interest rate paid on debt, and if the primary balance is negative.
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